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Ed Steer: Hitting a silver brick wall
Wanted: Psychopaths to Play the Stock Market
By Martin Waller
The Times, London
Monday, September 19, 2005
http://www.timesonline.co.uk/article/0,,11069-1786949,00.html
City brokers have never enjoyed the best of reputations. The popular
image is of a brash and boastful twentysomething with more money
than sense or sensitivity.
But now a study by a group of eminent American academics suggests
that star performers on the stock market may be even worse and could
best be described as "functioning psychopaths."
In a study of investors' behaviour, the team from three US
universities suggest that people with brain damage can make better
financial decisions than the rest of us.
Market traders may feel slighted, but this study comes from the
growing field of neuroeconomics, which investigates the mental
processes that drive financial decision-making.
The experts found that emotions can make investors play it too safe.
They claim the emotionally impaired are more willing to gamble for
high stakes.
The US team found that people with certain brain injuries that
suppress their emotions could make the best stock market traders.
They took a selection of 41 people of normal IQ, 15 of whom had
suffered lesions on the areas of the brain that affect emotions, and
made them play a simple investment game.
Those with brain damage significantly outperformed those without,
the researchers from Stanford Graduate School of Business, Carnegie
Mellon University and the University of Iowa found.
The key was the fear that stopped those with "normal" brains from
taking even the most sensible of risks.
Antoine Bechara, an associate Professor of Neurology at Iowa,
suggested that successful investors in the stock market might
plausibly be called "functional psychopaths."
These are individuals either much better at controlling their
emotions or, perhaps, not experiencing them with the same intensity
as others.
Baba Shiv, of Stanford, added chillingly: "Many chief executive
officers and many top lawyers might also share this trait.
"Being less emotional can help you in certain situations."
The study set up a 20-round gambling game, at the start of which
participants were given $20. At each round, they were asked if they
wanted to risk $1 on the toss of a coin.
If they lost, they lost the coin; if they won, they received
$2.50. "From a logical standpoint, the right thing to do was to
invest in every round," Mr Shiv, an associate Professor of
Marketing at the Graduate School of Business at Stanford University.
As the rounds progressed, the "normal" participants passed, becoming
cautious and concerned about conserving their winnings. Those with
lesions did not, and ended the game with an average of $25.70,
almost $3 more than the "normal" group.
The study is relevant, the authors say, to the "equity premium
puzzle" that has bemused financial experts.
This is the tendency of large numbers of investors to prefer to
invest in bonds rather than equities, even though the latter have
historically always provided a much higher rate of return.
When stock markets decline, investors shift to bonds, even though
over the long term this is not the best thing to do.
Emotions lead people to avoid risks even when the potential benefits
far outweigh the losses, a phenomenon known as myopic loss aversion
that scholars have concluded can explain, for example, why people
invest in bonds over historically higher-performing stocks.
George Loewenstein, a professor of economics at Carnegie Mellon and
a co-author of the study, said: "It may be the first study that
documents a situation in which people with brain damage make better
financial decisions than normal people."
Mr Shiv said: "Emotions serve an adaptive role in speeding up the
decision-making process.
"However, there are circumstances in which a naturally occurring
emotional response must be inhibited, so that a deliberate and
potentially wiser decision can be made."
The study does not mean that it is a good thing to have lesions in
emotional regions of the brain. Such patients generally make worse
decisions than those with intact brains. In this experiment, risk-
taking was the most advantageous behaviour, so the participants who
were less fearful made the better choices.
However, in other studies, the experiment has been set up so that
risky choices had lower expected values, and in these studies,
normal subjects tended to perform more optimally.
Emotions clearly play an important role in human life. This study
suggests, however, that there are situations in which they can lead
us astray. "Research needs to determine the circumstances in
which emotions can be useful or disruptive, and that can be a guide
for human behaviour," Professor Bechara said.
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